TalkingEconomics: China’s equity boom and bust

China’s equity market boom and bust should have a limited immediate macroeconomic impact, but we fear the seeds of a future crisis have been sown.

17 August 2015

Craig Botham

Craig Botham

Emerging Markets Economist

Immediate macroeconomic impact should be limited

Our view is that the real economy is still sufficiently disconnected from the equity market that the impact on growth should be limited to the effects felt by the financial firms involved and those wealthier households exposed to the bust.

Most firms are not reliant on the equity market for financing, and the People’s Bank of China (PBoC) is capable of providing ample liquidity to keep credit markets going.

But while the impact of the crash itself may be manageable, our concerns centre on the implications of the government’s response.

For a more in depth review of the global economy in August 2015 try:

TalkingEconomics: Eurozone political risk shifts to Iberia

TalkingEconomics: Global storm clouds lift

TalkingEconomics: Full August 2015 economic infographic

Financial stability risks

Attempting to reverse the slump in the markets, the government responded with a broad array of measures, including encouraging widespread equity purchasing by institutions such as the China Securities Financial Corporation and the sovereign wealth fund.

This has effectively spread the risk of a sustained equity downturn throughout the financial system. Another negative side effect is resource misallocation.

Specifically, bank credit is increasingly directed away from the credit market (and potentially economically productive uses) towards financing equity purchases.

This will further weaken the impact of credit growth on investment and GDP, at a time when all three metrics are struggling.

The rescue package has not yet led to the sustained rebound that was hoped for. We believe market participants have little faith in the government-sponsored rally, and that absent heavy intervention the market has not yet settled.

We expect further efforts from the government but we think this will ultimately prove to be an expensive mistake.

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